Riding Into The Sunset Or A Brick Wall?

A month ago, I presented the case for why Fed Chairman Bernanke would have strong motivation to launch another round of quantitative easing (QE) before the election. In short, it would save him his job. Now, I didn’t predict with certainty that he would do so – only the few men at the FOMC knew that for sure – but it seemed likely. Shortly thereafter, Bernanke not only announced more stimulus, but promised to keep it flowing to the tune of an additional $40 billion a month until conditions improve. As I had written, this is essentially the election platform of the Obama-Bernanke ticket: we will keep the party going indefinitely.

Unfortunately, though these are two powerful men, they are not above the law of economics. While critics have dubbed this program “QEternity” or “QE-Infinity”, it will end much before that. We are witnessing a massive bubble in US government debt, and we’ve reached the point where no one in charge believes it will ever end – an excellent contra-indicator.

Rather than going on for eternity, this third round of QE is only hastening the day when there is a flight of confidence from the dollar and US Treasuries. This will cause a sharp rise in market interest rates and surging consumer prices across America. If you think $4 a gallon gas is bad, wait till you see it going up by 25:¢ or more per week.

At this point, the Fed Chairman will have a choice to make: keep printing, which will push the dollar into uncontrollable hyperinflation, or begin tightening, which will bankrupt the US government and banking system.

I have long written about this Sophie’s choice confronting the Fed, but so far the printing option has been too easy. With the world only slowly abandoning the dollar as the reserve currency and the euro crisis offering a distraction, the Fed has been able to more than double the money supply without US consumers seeing out-of-control price hikes at the store. Not that there hasn’t been inflation – look at housing, gas, or the stock market – but it hasn’t reached crisis proportions. When prices start rising fast enough for the average person to figure out he’s being screwed, then there will be riots in the streets.

The good news for precious metals investors is that either scenario is bullish for gold and silver.

If the Fed pushes this insanity to the point of hyperinflation, precious metals will quickly be seen as a form of money that can purchase the same amount of goods week-after-week, month-after-month.

If there is tightening, prices might stabilize, but the federal government and its banking cartel will likely go bankrupt in tandem. That means no bailout money will be forthcoming, no FDIC insurance can be paid, and banks may go on holiday for lack of reserves. This is what happened in Iceland in 2008, when its big banks had debts 10X the size of the country’s GDP. There was no way for the government to offer a bailout, so the whole edifice came crashing down. While the 320 thousand citizens of Iceland didn’t make a big dent in the currency markets during this transition, you better bet the 320 million citizens of the United States will.

As we’ve seen in cases like Argentina’s in the ’90s and Hungary’s in the ’40s, when the banking system freezes, hard assets trade at a premium. Gold and silver coins may be at a disadvantage in terms of convenience in an era of credit cards and Paypal, but what happens when those funds are no longer available? Already, regulations and lower profit margins have driven banks to add fees to debit card transactions. Not to mention that every digital transaction is traceable by the tax authorities.

If everyone starts to carry rolls of cash everywhere, it’s not a big leap to carry coins. A silver coin the size of a dime is currently worth about $3.50. Two could buy you lunch.

While I believe a tightening and national default would put the US on the road to recovery, the transition period will be messy. Bread lines, rampant foreclosures, and a spike in crime are likely results. In this situation, gold and silver may be the only things people can count on. In fact, they are likely to not only hold their value, but dramatically appreciate as millions of people flood the metals market and the dollar economy deleverages. In plain English: maybe it will only take one of those dime-sized silver coins to buy lunch. Maybe that coin will buy lunch for you and a friend.

Bernanke and his Wall Street supporters see cheap money until the horizon – but that horizon is really a painted brick wall. So it’s not QE-Infinity, it’s QE until the Fed either recognizes the brick wall and slams on the brakes, or doesn’t and crashes into it. Either way, the only way to get off this locomotive is to invest in hard assets.